Yahoo pondering sale; what might Microsoft make of this mess? (Updated)

An update to yesterday's story. As Yahoo gets ready to make a big move in the …

Yahoo's board is exploring the possibility of a sale, according to the Wall Street Journal's ever-popular "persons familiar with the matter." The reeling Internet giant is said to be in the process of hiring bankers to evaluate options for the company, which could include anything from spinning off individual business units to an outright sale.

Our original story from yesterday, which follows, examines Yahoo through the eyes of its former suitor, Microsoft.

Original story: When Carol Bartz took the helm at Yahoo! in 2009, she promised a "back to the basics" approach. Three years later, the company is truly back to square one—as in looking for a new leader once again.

Bartz came in on the heels of Jerry Yang beating back an unwelcome merger proposal from Microsoft. She ended up signing a search partnership with Microsoft's Bing, but never seemed keen on selling the company outright.

So with Bartz out of the way, would Steve Ballmer be interested in making another pass at Yahoo?

Money matters

First of all, the price is right these days. If Mr. Softy was willing to pay as much as $44 billion for Yahoo once upon a time, the $16 billion market cap as of last night surely looks like a bargain. Add in a healthy dose of nearly debt-free cash on the books, and Yahoo's enterprise value becomes a paltry $13.8 billion.

But deep-discount prices aren't everything. In the words of legendary investor Warren Buffett, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." The price may be wonderful, but what would Ballmer get for the money?

Human resources

Going back to Ballmer's original offer, the software giant wanted to create a credible competitor to Google. "The industry will be well served by having more than one strong player, offering more value and real choice to advertisers, publishers and consumers," said Platforms & Services President Kevin Johnson (who left Redmond when the deal fell apart and now serves as CEO of networking runner-up Juniper Networks).

Yes, it was all about economies of scale and the efficient competition they bring: "The combination of these two great teams would enable us to jointly deliver a broad range of new experiences to our customers that neither of us would have achieved on our own," said chief software architect Ray Ozzie (who left Microsoft at the end of 2010).

Oh dear. There appears to have been some attrition on the Microsoft side of that power-broker equation.

Lots of top talent has left Microsoft since 2008, often to lead other global businesses like Juniper and Nokia. But the picture looks even bleaker in Sunnyvale, where the brain drain has been downright scary. A non-exhaustive list of post-Microhoo departures includes VP of Community Mike Speiser, del.icio.us boss Josh Schachter, SVP of Communities Brad Garlinghouse, Flickr manager Stewart Butterfield, advertising chief Hilary Schneider—and the list goes on for miles.

It seems obvious that Microsoft would only get a hollow shell of Yahoo's formerly robust glory for that deep-discount price. Mash this together with Microsoft's own, similarly anemic online division, and you'd get... something far short of a serious Google rival.

Let's do the math instead

So the talent base that once made Yahoo attractive to Microsoft has largely moved on to bigger and better things. Okay, but maybe Bartz whipped the company into decent financial shape before being shipped out? In that case, buying Yahoo would be a simple bolt-on move to improve Microsoft's online position and maybe even make some money on the deal.

From that perspective, the story looks a little less grim. Yahoo has widened its profit margins and grown earnings under Bartz. However, even this happier angle tells no fairytales. Those profits came at the expense of shrinking sales and slower-growing cash generation. In other words, Bartz made Yahoo look good to earnings-focused investors and analysts, but failed to improve the business where it really matters. Remember that earnings are an accounting construct mainly designed to determine tax expenses, and that the real measure of a business lies in free cash flows.

Math is hard! Let's go shopping.

All these things considered, I don't see why Ballmer would want to mail another offer letter to Yahoo's suddenly proactive board. The original rationale for a combination has eroded to nearly nothing, and Yahoo may be bottom-line profitable today, but those profits ring hollow.

AllThingsD says that private equity firms such as Silver Lake Partners and Providence Equity Partners have shown some interest in the company, which makes some sense; these guys are often turnaround experts and masters at squeezing cash from a seemingly bone-dry stone. But Yahoo is a big bite for a single equity firm, the diminished price tag notwithstanding, and joint buyouts are rare in this realm.

Ballmer might have thrown a few jubilatory office chairs in celebration as Yahoo walked away from what now looks like a tremendously generous offer. But then he'll sit on his hands, maybe hire a few post-Bartz castoffs, and that'll be that. When the dust settles, Yahoo is left to fend for itself while running the business by committee with CFO Tim Morse in the interim CEO chair.

Like AMD before it, Yahoo needs to find a top-notch leader very quickly lest Google, Facebook, and Twitter crush whatever's left of the old, proud powerhouse. And just like AMD, I don't think that anybody with the skills to do the job would be willing to take it. And so the long, slow death spiral continues.